Talking Valuation – a welcomed blast from the past

It was not that long ago that I was maintaining a bankruptcy watch list because sales trends for the casual dining industry were declining sequentially every month at the end of 2008. It got to a point where some companies were seeing 10-20% declines in same-store sales. The last data point for the industry was a 5% decline in traffic for February 2009.

The average Casual Dining stock is up 152% from the 52-week lows just three months ago. Brinker International (EAT) is up the most from the lows rising 295%; with Ruby Tuesday’s (RT) a close second, up 287%. The QSR group is only up 94% from the 52-week lows!

Currently, as a group, consensus estimates have average FSR revenue, EBITDA and EPS declining -0.5%, -3.2% and -19.7%, respectively. The same consensus estimates for the QSR group are 8%, 8% and 12%, respectively. Yes, the fundamentals are better at QSR, but as I said yesterday, the big market share shift from FSR to QSR is over. So for the domestic based QSR companies, fundamentals are not accelerating, but could decelerate. The global QSR companies face slowing demand overseas and currency related issues. Just this week, we got two negative data points regarding MCD’s international business. First, we learned that German business confidence fell to the lowest level in more than 26 years in March, and this follows on MCD having previously reported that Europe’s February sales were hurt by weakness in Germany, a trend that continued from the fourth quarter. Second, it was reported that MCD’s sales growth in Latin America will slow this year as a result of the recession. Woods Staton, the CEO of Arcos Dorados SA, which is the owner and operator of all of MCD’s restaurants in Latin America stated regarding sales, “If we grow by 5 percent, that will be good. It’s a recessive year.” This expected 5% sales growth compares to 26% growth in 2008. Given the fact that QSR companies could face slowing sales trends, there is not much upside to the group’s current average 8x NTM EV/EBITDA multiple. Although the group should trade at a premium to the FSR names, primarily as a result of the group’s more franchised business model, the names are not cheap.

For FSR, the business is getting less bad as most companies are trying to narrow the price gap at lunch with the QSR names. Given the rally we have seen in the FSR names, however, we don’t have the valuation support for some of the key names. The large cap casual dining names are now trading at 7.0x times NTM EV/EBITDA, with the overall FSR group trading at 6.0x. In the heyday of the buyout craze, 9x NTM EV/EBITDA was the peak multiple. For the FSR group, sales trends are less bad, but it’s hard to make the case that NTM EV/EBITDA estimates are low, providing limited upside from the current levels. That being said, it is important to note that the FSR group continues to have higher average short interest at 14% relative to the QSR group at 10%, which provides some support to the FSR names.

We are still buyers of large cap, early cycle casual dining names (EAT, DRI, CAKE and PFCB) on down days. Right now I’m working on some of the names that have lagged so far this year like MSSR, MRT and LNY. Another thought would be to look at the QSR names that have underperformed so far this year like SONC, PEET, JACK, WEN and CMG. I continue to favor SBUX.

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